Alternative Minimum Tax

by Tim Foster

Realize that if you are not paying AMT now...you might become part of the tax base in the future.

What has been around since the 1960’s, is responsible for raising approximately $100 billion a year in revenue, affects more and more individuals and business owners each year and is widely misunderstood? If the word "tax" was anywhere in your answer, I’ll give you full credit. However, the correct answer is the Alternative Minimum Tax or "AMT." What is AMT? AMT is a tax that should be called "Congress’ Plan to Take Away More Benefits You Weren’t Even Sure You Were Taking Full Advantage of in the First Place" TAX.

AMT was introduced in the late 1960’s to correct the problem of 155 taxpayers, many of them millionaires with income exceeding $200,000, using loopholes to avoid paying federal taxes. The goal at the time was to ensure the extremely wealthy paid their fair share. So why do you need to worry about AMT? Inexplicably, AMT has not been adjusted for inflation since its inception. Therefore, since the initial target was wealthy taxpayers with annual incomes, in today’s dollars, AMT now impacts upper middle class taxpayers with annual incomes of $75,000 - $100,000 and up. It is estimated that by 2010, 30 million taxpayers will pay this additional tax.

How AMT works

Sound tax planning for regular income tax seeks to maximize the utilization of deductions and credits. Throughout the years, Congress has been able to encourage certain behaviors by creating tax advantages for them. Normally, owning a business, home or rental property creates an opportunity for additional deductions to be taken in order to reduce a business owner’s overall tax burden. It certainly makes sense to encourage business ownership, home ownership and therefore new home construction and maintenance and upkeep of rental properties, for residential and business needs, to maintain the nation’s overall economic wellbeing. It’s difficult to dispute the government’s rationale for encouraging such entrepreneurial behavior. Unfortunately, because AMT has never been adjusted for inflation, more business owners are losing the benefits from these tax preference items each year. AMT doesn’t stop there. The AMT calculation also reduces deductions that allow you to offset the high costs of raising a family by lowering the deductions for dependent children. The more children you have, the more it hurts. Ouch.

Calculating AMT

The more you familiarize yourself with AMT, the easier it becomes to understand why the Internal Revenue Service commonly refers to it as one of the most complex and complicated parts of the tax code in terms of compliance, administration and taxpayer awareness. However, while preparing this article, I was surprised by the number of CPAs I spoke with who admitted that they did not fully understand the calculation of AMT. Instead, they relied on their TAX COMPLIANCE software to calculate the tax. Unfortunately, effective TAX PLANNING software doesn’t exist.

The first step is to calculate your regular personal income tax on Form1040. Second, calculate AMT on Form 6251 (the 10 page instruction book should help – if you are looking to cure your insomnia). Step three is to take out your checkbook, and write another check to the government. The AMT tax rate, originally a flat 10 percent, is now 26 percent or 28 percent depending on income. You must pay AMT for the amount over and above the tax calculated for your regular personal income tax on your 1040. Think of AMT as a penalty for conducting your personal and business affairs to take advantage of all available credits, deductions, exemptions and deferrals.

But don’t throw in the towel just yet. AMT is simply another reason why business owners need to seek more advanced tax planning to stay ahead of the competition. The big companies are continually seeking proactive ways to minimize the effects of AMT; you should do the same. A few AMT planning ideas will be discussed following.

Corporate AMT

S Corporation shareholders do not need to worry about corporate level AMT tax. These shareholders will pay all AMT on their personal returns. C Corporation shareholders could potentially be responsible for a corporate level AMT. AMT will become an issue for C Corporations when the average sales revenue exceeds $7.5 million for the prior three years. The current corporate AMT tax rate is 20 percent.

Tax planning and AMT

As long as this tax continues in its current state, the only hope you have to minimize its impact is proactive tax planning. As a business owner, this MUST be your plan for both personal and corporate level taxes of all kinds – especially with AMT, as it is so widely misunderstood. If your CPA is merely relying on tax software to calculate the tax at the end of the year, you will end up paying too much tax. The result is more unnecessary money out of your pocket. You need a qualified tax planning professional "coaching" you instead of simply adding up the score at the end of the year, as this will result in a loss at the end of the game.

With a knowledgeable advisor, you can proactively understand the potential regular and AMT tax impact on transactions you are considering. Examples of areas you need to inquire about include:

Home Equity Loans – If you are considering a home equity loan to pay bills, credit cards or finance a new car, because the interest is deductible for regular income tax purposes, you may want to think again. The interest deduction would be nondeductible for AMT purposes and therefore would have to be added back. If the home equity loan is for home improvement, it would be deductible for both regular and AMT.

Depreciation Deduction for Manufacturing Equipment – The number of years for which equipment can be depreciated is extended for AMT purposes. The result is a smaller annual deduction for AMT relative to regular tax. Please note that timing and planning is vital. If the total new equipment purchase is $500,000, the first $125,000 can still be written off in the first year for AMT purposes. Check with your professional BEFORE you buy the equipment to maximize the deduction.

Depreciation Deduction for Rental Property – Rental property that can be depreciated over 27 ½ years for regular tax purposes might have to be depreciated over 40 years for AMT purposes. The result is a smaller annual deduction for depreciation and more tax due each year.

Taxes – Deductions for state income, real estate and employment taxes permitted for regular tax purposes are eliminated for AMT. So, if your tax strategy includes paying these taxes early to get the accelerated deduction, AMT would eliminate the benefit.

What you can do

Now that you have an awareness and basic understanding of the Alternative Minimum Tax, utilize proactive tax planning to minimize its corporate and personal impact. It is important to realize that if you are not paying AMT now, as your income increases, or if the deductions you take increase, you might become a part of the growing AMT tax base in the near future.

If you don’t want to do the planning to minimize the tax, perhaps you can petition your U.S. representative to eliminate the tax. He or she is likely to be extremely busy, so you may want to have an answer as to how the $100 billion in lost annual revenue will be made up. When you give up, give me a call and we can do some proactive tax planning.